What is the key to a successful M&A transaction?
In this episode, Joseph Durnford, who was recently inducted into the M&A Advisor Hall of Fame, will give his insight on that question.
As chairman and senior managing director of JD Merit, Joseph has seen market-transformational transactions.
He’s here to share his wisdom on all things M&A, from reps & warranties to his firm’s ideal clients.
Mentioned in this episode:
Patrick Stroth: Hello there. I’m Patrick Stroth, trusted authority in executive and transactional liability and founder of Rubicon M&A Insurance Services, now a proud member of the Liberty Company Insurance Broker Network. Welcome to M&A Masters where I speak to the leading experts of mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors.
Today I’m joined by Joseph Durnford, Chairman and Senior Managing Director of the award-winning investment banking firm, JD Merit. With seven offices throughout the US JD Merit is comprised of forward-thinking bankers who get deals done, real simple. Their motto, your future, our focus. And also it’s great pleasure to have JD here to us today, because he was just recently inducted into the M&A Advisor’s Hall of Fame. So JD, welcome. Congratulations to that. Thank you for being here today.
Joseph Durnford: Well, thank you, Patrick. And thank you to the audience for tuning in today. It’s a real pleasure to be here.
Patrick: Now before we get into your firm, and the practice and so forth, let’s start with you. What brought you to this point in your career?
Joseph: Well, you know, when I was nine years old, my brother and I were asked what we wanted to be when we grew up, and my brother quickly said he wanted to be a pilot. And I said, I wanted to own the plane, and be a businessman. Now, neither one of us knew what it was going to take to achieve that those years ago. But he is a pilot, and I have once upon a time had a plane. So we both achieved those goals. And, you know, for me, the path to being a businessman entrepreneur, was comprised with lots of mentors, lots of great people that I had a chance to work with and learn from along the way.
Beginning with my, my high school football coach, Coach Martin, who was also the accounting teacher. And he mentioned that his brother was a CPA in Arizona, and he made $100,000 a year. And, you know, back in 1981, I thought that was all the money I would need to own plane. You know, I asked what it took to become a CPA and I decided to major in accounting and finance, in school. And ultimately, that led me to becoming a CPA and starting my career at Deloitte, Haskins & Sells.
That dates me now it’s just Deloitte. And spent several years working there in the emerging business consulting group. And ultimately, the transaction advisory group. I had the great pleasure of working with some brilliant tax strategists, tax minds, and including people that were instrumental in putting together the, the RJR Nabisco deal, which was featured in Barbarians at the Gate.
So this was a prominent one of the first large LBOs and in the history of our industry. And, yeah, so I had a chance to learn from some really smart people. And I spent a number of good years there and ultimately, did a stint as a CFO for a technology company. And then, you know, when I was at Deloitte, I had developed a business plan to represent entrepreneurs. Our business was primarily representing private equity firms. KKR, Thomas Lee, you know, the large private equity firms back in those days.
And, you know, our job was to come in after a letter of intent had been signed, and to utilize financial engineering and accounting tools to find ways to reduce the price. And if we couldn’t reduce the price by 10, or 20%, we didn’t think we’d done our job. I never really felt great about that, being an entrepreneur at heart. And I suggested that Deloitte have a sell-side practice and represent the other side of the transaction.
I was ahead of my time quite a bit. They are now in that business, but 30 years ago, they patted me on the head and said, keep your head down, and you’ll be fine. And you’ll be able to ultimately be a partner and we make we make lots of money doing what we’re doing. So just keep on doing a good job. Well, I at the same time was being told no, I was given an opportunity to be a CFO for a semiconductor company, which that was a great, great experience. And, like all good CFOs I sold myself out of a job.
We sold the company to National Semiconductor and I moved on to Coopers and Lybrand, now PricewaterhouseCoopers. They were interested in being in the sell-side investment banking business, and they’d heard about my business plan, and they invited me to join the founding team at Cooper’s Lybrand securities. And there again, I got to meet and work with some very, very talented people.
You know, people who I learned a lot from and I hope I contributed a little bit to their experience. But sadly, with a large organization like PricewaterhouseCoopers’ success, which we were having in our Denver office, meant relocation to a bigger office. And they wanted me to move to New York City and keep on doing what I was doing. And my wife and I were both from Colorado and we didn’t want to move out of state. I was on the road a lot. So we’d had our first child. So I was told it really wasn’t a choice I was going to relocate.
And I told the firm while I think it is a choice, and I ultimately left and I started my own firm JD Ford and Company now, JD Merit and Company. And that was about 28 years ago now. So I had a great, great run with some really great colleagues along the way, and some great clients. And, again, I’ve had a chance to learn a little bit from everybody I’ve interacted with over a long period of time.
Patrick: Well, and the great thing is you had been at those milestone events in mergers and acquisitions. And then, you know, working on the larger side-side of the table, the experience side, you know, representing buyers, I think you had a real advantage when you were dealing with sellers. And you just flip that around, and you thought, let’s bring my talents over to the sell-side of the table and help out those entrepreneurs. So tell me as you brought in, got into JD Merit, is that the focus where it is just real sell side advocacy. So it’s not only just finding deals, but getting the right deal done?
Joseph: Well, we certainly always believe in getting the right deals done, whether we’re on the sell side or the buy side. We’re also a FINRA-registered broker-dealer. So we raise capital as well, for growth and recapitalizations. You know, most of our business is on the sell side. It’s where I spend my personal time, it’s where I enjoy the business the most, is working with founders and entrepreneurs to ultimately create their first liquidity event as they move forward in their career. And, you know, you mentioned I started with some larger firms doing large deals.
And when, when I started JD Ford and Company, I think my transaction size for my first deal, I think, was a million dollars. And, you know, so, you know, from humble beginnings, we have we moved up the league tables, as they say, in our business. And, you know, now our typical transaction is in the 50 million transaction size. Still very small compared to the broader market. But, you know, the vast majority of companies in America are worth less than $200 million. And, we work in that large majority of entrepreneurial family-owned businesses.
Patrick: And JD Merit is not the only sell-side advisory investment banking firm out there. There are quite a few, especially in the last, you know, 5, 10 years, how many more have been emerging because there are people like you that are being pioneers setting up their firms. What separates JD Merit from the rest of the firms out there? What are you bringing to the table to the lower middle market?
Joseph: Well, I think what we bring to the table to lower middle market, and you’re right there, there’s lots of firms in the world that do what we do. And we like to think we bring something unique and differentiated. First, we only work with clients that we really fundamentally believe we can add incremental value to. We’re not just about running a process. Lots of people talk about the M&A process. And certainly, we have processes and procedures that we utilize in our business.
But the real key to a successful M&A transaction is to understanding the reasons why. And understanding how to position a company properly so that we can both identify the puzzle that they would fit best into and then demonstrate whoever is missing that piece of the puzzle that our client just happens to be the best solution. Give you a quick example of that. We had a client recently that was doing about $8 million a year in software as a service revenue.
The company who had been in business for about 12 years had just become profitable. The entrepreneur was, you know, kind of burnt out from the business. They thought there were other things he could go do. And, this was a relatively small niche. You know, we asked him what his expectations were, and he said he wanted two maybe three times revenue for his SaaS business. And we asked him what he thought the total addressable market size was for the business.
And he said, you know, maybe 60, 65 million, that would be the total global market for what we do. And so we challenged him on that. And we tried to help him understand how you could redefine the solution offering that he was, you know, the expert in and how we could define that market to be substantially larger than that. As a result of that thoughtful positioning and understanding where he fit best, we were able to sell the company for over nine times revenue.
Joseph: A very substantial amount of money. Far greater than he had anticipated. And we were correct in it being the missing puzzle piece. Because 90 days later, the company that acquired him, was owned by a private equity firm and they sold for 12 times revenue to a strategic player. So it was a win-win for everybody and I think demonstrates what we do differently which is really being thoughtful and how we position our clients to maximize the value.
Yeah, that’s just one example of the things we do. We’ve been fortunate to be recognized by the M&A Advisor and other organizations in our industry that we deliver far beyond what is expected. We have market-leading transactions, in some cases, market-transformational transactions. And people scratch their heads and say how’d they do that. So that’s what we do that’s different.
Patrick: Yeah, I think what’s striking about this, and this is why I’m so thrilled to have you and you know, highlight JD Merit out there is that you’re not looking at the transaction, you’re looking at your client with a different set of eyes from a different perspective of their business, and asking them the right questions to say, well, you look at your business one way, and you’ve been, you know, enmeshed in it for years, okay?
Why don’t we look at it from a couple of different angles that you didn’t think of, because you’re in the day-to-day slog. And all of a sudden, a lot of these opportunities open up. And I just see so many firms out there that they reach this point of inflection where they’re too big to be small, but they’re too small to be enterprise. And they want to take that next leap, but the talent pool and the experience that got a company to a certain point isn’t going to get them any higher.
And you just don’t go, you know, if people didn’t know about JD Merit, they’d be out there and defaulting to a strategic or maybe go to a large institution to see if they can help, you know, manage the sale and they get underserved. Joe, give us a profile of the ideal client for JD Merit. What are you looking, who are you looking to serve?
Joseph: Well, our clients, again, are primarily founders and family-owned businesses, typically there have revenues of 25 to 250 million. They’re always profitable, they typically have, you know, EBITDA earnings before interest, taxes, depreciation, north of 5 million. We do work with companies less than that, for example, the example I used earlier, that company had 8 million in revenue, and it was barely profitable. And we sold it for nearly $70 million. So we look for situations where we can find the angle for the client. We look for situations where we can differentiate them in the marketplace, so that they win.
And ultimately, we win. The reality is business owners who choose to sell their business usually sell it for one of three reasons. One, they run out of capital. They just, you know, whether it’s human capital or financial capital, they just don’t have the resources to go to the next level. And they acknowledge that and they want to team up, or team the company up with somebody who can take it all the way. So they run out of human or capital.
Or they run out of time. They reach a point in life where we all have, we all have an end date, we don’t know when it is. But the closer you get to it, the more I think you recognize it. And we run out of time. And there are many things to do in life, other than being an entrepreneur. So people realize they want to do something different. And that doesn’t mean that they’re all you know, 75 or 80 years old.
One of my favorite examples of that is Lara Merriken who was the founder of Larabar. Lara was a very successful natural products entrepreneur. Created a great a great company, a great product. But she had given it her all to achieve the success that she had in business. She was 39 years old, she had a desire to have a family and to have a life outside of being an entrepreneur. And she didn’t think she could do a good job of being both a wife, mother and an entrepreneur.
So she wanted to sell the company before she was 40 years old. That was her timeframe. So she came to us and we were able to ultimately structure a transaction with General Mills, which worked out really great for them and for her. And it happened the day before her 40th birthday. And I remember her being so happy that you know, the newspaper said Lara Merriken, 39, sells company to General Mills.
And the really great moral of that story is that environment, that event created a circumstance where her son Oliver was able to come into the world. And so that was you know, he’s now 15 years old. So that was quite a while ago, but it was her timeline. And you know, she had just reached the end of what she wanted to do with her entrepreneurial journey. You know, the third reason people come to us and sell their companies is they run out of interest.
They’re just bored. They want to do other things. Entrepreneurs are great people and they’re innovative and lots of ideas and to be a really good entrepreneur, you got to focus. And once you’ve given it all to a certain event and you want to focus on something else, you know, they come to us and say let’s go do something else. And we help them have a liquidity event to free them up to the next adventure.
Patrick: Now, we’ve noticed over the last several years, there’s been an explosion in the number of investment bankers and sell-side advisors like you, as well as private equity firms and other types of buyers out there. And the reason why is because there are a lot more M&A deals today than there were 10 years ago.
A key reason for that is that the insurance industry stepped in and came up with a product to take risks away from the buyer and seller and transfer it away to the insurance company. It’s a product called reps and warranties insurance, and we believe it’s one of the key drivers for really accelerating the expanse of M&A. But don’t take my word for it. JD, good, bad or indifferent, what’s been your experience with rep and warranty insurance?
Joseph: Well, rep and warranty insurance is a great tool for a dealmaker. It doesn’t work in every situation. But it’s a great tool, because fundamentally what it does is it enables both parties to de-risk from the transaction document itself. In any M&A transaction, there is going to be a document that’s called the definitive purchase agreement. And in that definitive purchase agreement, there’s going to be pages and pages of representations and warranties that the seller is making to the buyer saying, you know, I don’t have the skeleton hidden in this closet, I don’t have the ant buried in this environmental wasteland.
And, you know, these are promises I make. And if I break those promises, then obviously I owe you money to the buyer. So, you know, before reps and warranty insurance came into play we’ve fought hard on well, what’s the definition of knowledge? And do we have to investigate? Or is it just what we know right today, and we’d spend a lot of time narrowing the field of what those reps and warranties were, and what the indemnification elements were.
On the indemnification side before reps and warranty insurance came in, buyers, you know, they wanted to basically hold the seller accountable. And say, it’s great that we’re going to accept your promise, but we’d like you to put some money in an interest-bearing but low-interest-bearing escrow account for some period of time.
Whether it’s 12, or 24, sometimes 36 months back in the day, and anywhere from five to 15% of the purchase price would be held in a for the benefit of the seller, but not accessible to the seller until certain contingencies were removed. With the introduction of reps and warranty insurance, you know, we didn’t have to negotiate so hard on what those indemnification caps were going to be because we could replace the indemnity with an insurance policy so that the buyer can get insured up to the full purchase price.
And the seller can be at risk for only the deductible in the policy. So it is a really great tool. It’s made deal making a lot more efficient. It’s helped to sort of level the playing field. You know, we’ve all heard the story that lawyers kill deals. Well, great lawyers make deals. We, you know, we love working with great lawyers and, and the other some of the some of the best deals I’ve ever done, because some lawyer had a great insight.
But then there are those who are not full time practitioners of M&A law, and they get excited about being involved in a transaction, and so they, you know, they get into something that’s not their day-to-day. And sometimes that makes the deal a lot harder than it needs to be. With reps and warranty insurance we can kind of smooth things out a little bit regardless of the stature of the experience of the law firm.
Patrick: I think it’s contributed tremendously, not only with the, you know, transferring risk away, but lowering the stress level in the room, eliminating the finger pointing particularly post-deal. And it’s really enabled, you know, organizations, particularly private equity, to become a real repeat buyer, where in the PE world it’s almost ubiquitous to have rep and warranty.
Joseph: I’m sorry to cut you off. One of the real reasons I think that it’s a great tool in the private equity world is private equity transactions and private equity has exploded over the last 20 years in terms of its relative importance in the market. Today it accounts for over 40% of overall M&A is completed by private equity firms. And you know, with private equity, more often than not, their transaction structures have a rollover component of the purchase price.
So if somebody has paid $50 million for their business, they may be asked to roll over $5 million for continued ownership interest in the going forward company. Well, with reps and warranty insurance if something goes badly in the transaction post-close. You don’t end up fighting amongst shareholders, right because you have a seller who’s probably still involved in the business, has an ownership interest in the business, may still be the CEO of the business.
And they, you know, they don’t have to go defend themselves in court. When there’s a, you know, perceived breach of a rep or warranty, they can let the rep and warranty insurance cover that. The partnership and the shareholder agreement can stay intact. And everybody’s happy to just keep working together.
Patrick: And it provides a real elegant solution to avoid conflicts, particularly if there’s something that the seller, quite frankly didn’t know about. And it’s out of the seller’s control. But it happened after you know, post-closing, it’s discovered. That can get very uncomfortable, like you said, and so this eliminates that. I think what we’re very proud about is not only has the insurance industry stepped up in the larger deals with their program, there is now, they’ve launched a rep and warranty program for deals priced between a million and $30 million in purchase price.
Now it’s a sell-side policy, as opposed to the traditional buy-side policy. But what it does is it protects the seller, it is triggered when the buyer tells the seller about a breach that costs the buyer money. Seller reports the breach to underwriters, underwriters pay the buyer. And so the underwriting process is simpler. It focuses on smaller deals, so they’re less complex. So they’re simpler to underwrite. There’s no underwriting fee.
And the great thing is at a cost of 15 to $20,000 per million in limits, I mean, is a fraction of rep and warranty without the need for outside diligence or underwriting fees. So we’re very, very happy about that. And we’re hoping that organizations like JD Merit that are out there are, you know, in situations where there’s a company that could be considered an add-on as opposed to a platform.
Or you know, one of those smaller things that you know, what buy-side rep and warranty isn’t available. And so now there is a solution there, which puts us on the sell side of the table, as opposed to the buy side of the table. So we’re very excited about that. We look forward to that.
Joseph: Yeah, I’m excited about that, too. That’s, that’s another innovation out of the insurance industry that I think will be a great tool for dealmakers. I’m excited to have our firm, you know, start to use it in the transaction situations where it fits. And, you know, I was excited when you told me the first time and I’m still excited now that we’ve talked about it a couple times.
Patrick: Well, I’m glad you’re excited about insurance. That’s always fun for an insurance guy when he hears that. JD, we’re getting through the first quarter of 2023. We just passed Silicon Valley Bank in the banking head waves and then we’ve got all these other economic headwinds facing us. What trends do you see going forward for mergers and acquisitions either in the lower middle market or for JD Merit in particular. What do you see out there?
Joseph: Well, the first quarter of 2023 has been a little soft with respect to overall deal-making. With the rapid rise in the cost of capital, valuation, the gap between a seller’s expectation of value and a buyer’s willingness and ability to pay that expectation, that gap is getting wider. The buyers are always very in tune with the cost of capital and what it means for valuation.
Sellers, oftentimes are relying on you know, brokers or intermediaries that give them a list of comparable transactions from the last two years. Or their buddy in the industry sold for six times EBITDA in 2021, which was a really great M&A market. And that’s what they want. That’s their expectation. Well, as the cost of capital has gone up, the ability and willingness of buyers to meet that ask, is getting tougher to overcome. So we’re bringing back you know, tools such as earnouts, and other kinds of contingent payments to try to bridge those gaps.
But you know, the market is more complex, it’s tougher. I think there will also be a bit of a shakeout between the bankers who are really skilled professionals in this industry and those who are running a process. A process by itself will not get deals done in this market. I suspect 2023 is going to be a relatively soft year. You know, private equity, they’re cautious, they’re smart, they’re going to deploy capital opportunistically, but judiciously.
Strategies are looking at their balance sheets and listening to their boards of directors and listening to what’s happening in the economy and saying, yeah, maybe we should hang on to that cash just in case or, you know, heaven forbid, our bank should fail. Right? And that’s something that we wouldn’t have even contemplated. Even three months ago, we wouldn’t have contemplated that Silicon Valley Bank, one of the key institutions for entrepreneurial lending in America would no longer be.
And I guess the good news is that capitalism fills the void. I get an email or two, almost every day about a new private you know, finance solution for, you know, growth-oriented companies that lack the balance sheet that, you know, Silicon Valley Bank was willing to lend into those situations and more traditional banks were not. You know, there’s new private capital coming in to fill the void. So, you know, it’s going to all shake out well in the end.
The future will look different than what we all think it will. But it’s still going to be bright and still robust. And I’m still a big believer in, you know, the American system and the entrepreneurial spirit and people building companies and creating value and, you know, rewarding investors for taking risks with them.
Patrick: You can’t turn off innovation. Joseph Durnford, recent inductee to the M&A Advisor Hall of Fame, how can our audience members find you?
Joseph: Best way to find me is, you can find me on LinkedIn. You can go to jdmerit.com and schedule a discovery call with me. 30 minutes, I’m happy to talk to anybody who wants to discuss you know their business, and their future, and their exits. Or you can email me at joe.durnford, d u r n f o r d @jdmerit.com and Merit is j d m e r i t with one T.
Patrick: There you go. JD thanks so much for being here. We learned a lot today and it’s a real thrill meeting you and your organization. I look forward for us talking again very, very soon.
Joseph: I do the same, Patrick. I look forward to doing deals with you.
Patrick: Yeah, me too.